One of the more contentious issues I’ve faced in my work with family businesses involves distributions made by family businesses to passive owners, or if applicable, the lack thereof. As used here, these are periodic payments to family member-owners who don’t work in the family business and receive no compensation for services provided to the business. In some cases, these passive owners may be retired former employees, while others may have received their ownership interests via gift or inheritance.
As the title of this article suggests, not receiving distributions, or receiving less than expected amounts, often causes resentment among passive owners. This can even occur when the underlying business isn’t performing well enough to make distributions. Regardless of the reason, anyone familiar with family businesses knows that dissatisfaction among passive owners can cause or exacerbate family conflict, and when severe enough, can even lead to time-consuming and expensive litigation.
Based on my experience working with family businesses, there are often recurring elements found in these situations. One of the more important of these falls under the general heading of communication. Specifically, is company management communicating useful information to its passive owners regarding distributions, and if so, is it doing so on a regular basis?
While information about distributions may only represent a portion of a company’s overall communication with its passive owners, if there isn’t much communication occurring, information about distributions will likely be just as scant. Here’s a quick check: When payments are being made by the business, are they expected by the recipients, or are they viewed as occurring “out of the blue” timewise? Here’s another: Is it clear how the payment amounts are determined? When distribution amounts aren’t determined by any formula or measure, such as a percentage of net profit, dividend rate, etc., payments may appear to be arbitrarily determined, even if that isn’t the case. This belief may be enhanced when the payments don’t follow any kind of a schedule, such as annual, quarterly, etc.
Since potential solutions often come from the underlying conflict, here’s a brief overview of some of the related communication issues we’ve encountered when dealing with this topic, along with potentially helpful suggestions. These are followed by additional suggestions related to the payment of distributions to passive owners.
Management often believes that it is communicating effectively, and if it isn’t, it’s the fault of the passive owner/recipients. For example, management often notes that it doesn’t have the time to answer “the same questions over and over,” or to explain basic business or accounting concepts to passive owners. Some information may be seen as too “sensitive” to be provided to outsiders. Management also frequently objects to providing the same information multiple times, and receiving excessive phone calls or emails during the working day.
Recipients, not surprisingly, often see things quite differently. Sometimes, the issues are very basic, for example, company emails are being sent to people who don’t regularly use email. A less basic example involves non-financially literate owners receiving dense spreadsheets and/or detailed financial statements without summaries or other user-friendly commentary. Other recipient issues often include management ignoring information requests, or management responses delayed for so long that they pass on stale information.
For businesses struggling with this issue, consider starting with something basic, like time. If the business incurs unproductive time whenever this issue arises, management can use this loss of time as a catalyst to change the status quo (while not losing face).
Since management controls the information flow, change will have to come from it. The following are suggested management-centric changes that could help a business in this situation change the communication dynamic with its passive owners.
- Responding to Queries: Consider having management revisit its willingness to respond to its passive owners, including the notion that being permanently “too busy” isn’t realistic. If possible, establish periodic (e.g., annual, semi-annual) Q&A meetings or calls to address questions and requests from passive owners. Schedule these meetings in advance and stick to the schedule, even if there isn’t breaking news to share. Designate a specific time period, such as Monday through Wednesday of the week prior to each meeting, as the time for these owners to submit questions and requests to management.
- Information Requests: Consider re-thinking continuing information requests from owners. What information requests are being refused, and as a way to avoid conflict, can this information, or a substitute, be provided? For example, typically a business will provide financial statements on at least an annual basis. If the passive owners desire more frequent financial statements, consider providing snapshots of key information, such as sales, operating income and total assets. Some requests, such as for litigation status updates, may be considered too sensitive to divulge outright and may require a separate response during the periodic meetings, such as a short conference call with a litigation attorney.
- Neutral Messenger: For situations with high levels of animosity, consider replacing management’s representatives, at least initially, with a neutral person who will attend the meetings with the passive investors. Depending on the circumstances, this person could be a board member who is respected by management and the passive owners. He or she could also be the company’s outside CPA or attorney. What matters most is to find someone who has credibility with both management and the passive owners.
Regarding distributions, among the numerous issues that arise are the following, expressed as questions: Are distributions currently being paid, and if not, why not? If they are being paid, or could be paid, how much should be paid? What happens when a business cannot afford to make payments to its passive owners?
Are distributions being paid? At the end of the day, passive owners are equity owners who have certain rights and expectations concerning sharing in the fortunes of the business. If the main reason why distributions aren’t being paid to passive owners is due to family acrimony (i.e., the business is capable of making payments to all owners, but management is unwilling), the chances of conflict are greatly increased. While the facts and circumstances of each situation will determine whether there is a meaningful chance that the conflict could escalate and result in lost time and management focus, as well as unnecessary expense (including possible litigation), as stewards of the business, management should act prudently and with as little emotion as possible.
How much to pay? If the economics of the business warrant payment of a distribution, but management is uncertain of the amount to pay, it can call on numerous resources for assistance, ranging from outside consultants to knowledgeable service providers such as the company’s accounting firm, law firm, etc. Also, obtaining outside assistance from neutral advisors may be helpful if the amounts are subsequently challenged by the passive owners. (By the way, we have seen instances in which companies routinely utilized compensation consultants to determine the executive payroll, but ignored outside consultants when determining how much to pay its shareholders.) Other possibilities include benchmarking, such as distributing a similar percentage of net income as other companies in the same industry; establishing an annual payment amount per share, such as one dollar; or distributing a percentage of any excess cash that might exist.
Inability to pay. When a business legitimately cannot afford to make discretionary payments to its owners, it should communicate this to the owners along with cogent reasons for its inability to pay, and whenever possible, information about the status of future payments. (Neutrals may be helpful here.) This is true even when the business isn’t capable of making payments (think Great Recession) because passive owners may not be on the same page as management. Sometimes, when cash flow is tight, accommodations can be made to the outside owners. For example, payment to serve on a rotating board of directors may help an owner meet his or her economic needs for a certain period of time. Likewise, whenever possible, even a greatly reduced payment or dividend is generally preferable to none at all.
Jim Hart, founder of Lightfoot Group, LLC assists families and family owned businesses working through disputes and intergenerational conflicts. He can be reached at email@example.com and at 678-320-0079. This article is designed to provide general information and is not intended to provide specific legal, accounting, tax or other professional advice. You should consult your professional advisors for assistance with respect to any matter discussed in this article.
© 2016 James F. Hart, Lightfoot Group, LLC